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Always look on the bright side

2 June 2021 By Swaha Pattanaik

Exceptionally strong U.S. economic reports no longer surprise investors. Meanwhile, measures of market volatility suggest asset prices are expected to be serene in the months ahead. Taking good things for granted can, however, be dangerous.

The Citi Economic Surprise Index reflects how prevalent optimism has become. The gauge shows U.S. data is overshooting expectations by small margins even though the U.S. economy grew at an annual rate of 6.4% in the first quarter, the second-fastest growth rate since 2003, and there’s every sign the boom will continue. For example, the Organisation for Economic Co-operation and Development on Tuesday upgraded its U.S. growth forecast for the whole of 2021 to 6.9% from 6.5% previously.

With the economy roaring ahead and Federal Reserve Chair Jerome Powell’s foot still on the accelerator, expected asset-price volatility is falling. CBOE’s VIX Index, which measures expectations of short-term stock-price volatility, has halved from its January peaks and VIX futures are similarly subdued. And the ICE BofA MOVE Index of one-month implied volatility for U.S. Treasuries has fallen by more than a quarter in the past three months. It is now below its 10-year average, as are measures of how much U.S. government bond prices are expected to gyrate in the next three and six months. Implied volatilities for major exchange rates have also subsided this year.

Once a robust recovery is so fully priced in, even small setbacks could rattle investors. Both business and consumer confidence readings have regained ground along with the economy, but the trajectory is not guaranteed. The University of Michigan’s index of consumer sentiment fell back slightly in May from April as households grew more concerned about a pickup in inflation, a report showed last week. And while U.S. manufacturing picked up in May, companies and suppliers struggled to meet rising demand because of shortages of raw materials and labour, the Institute for Supply Management said on Tuesday.

The Fed has so far viewed such bottlenecks and price pressures as temporary phenomena that don’t require the U.S. central bank to react. But any sign of that changing would deliver a huge jolt to investors. Their ability to keep looking at the bright side of life usually only lasts as long as everything is going their way.

 

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